© Noordhoff Uitgevers bv

Basics of
Financial
Management
P. de Boer
M.P. Brouwers
W. Koetzier

Second edition

Noordhoff Uitgevers Groningen/Houten

 © Noordhoff Uitgevers bv

Cover design GK Designers, Groningen/Amsterdam

Cover illustration © iStockphoto

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© Noordhoff Uitgevers bv

Preface

Basics of Financial Management offers a complete introduction to the

disciplines of finance and accounting. It can be used by first-year students
enrolled in higher education programmes in business administration or
other academic programmes that require a basic understanding of financial
management.

Basics of Financial Management is the international version of the Basisboek

Bedrijfseconomie, a successful textbook for the Dutch higher education
market for more than twenty years. It is not just a translation. The topics in the
book have been adapted to an international, mostly European, context. The
second edition of Basics corresponds to the ninth edition of the Basisboek.

Our aim is a student-centred approach, using clear language and terminology,

a logical theory structure, including many examples, illustrations and test
questions to ensure that students absorb the study material as effectively
as possible. New is the use of photos with accompanying text, to build a
bridge between theory and business practice.

In order to make the book more adaptable, we have re-arranged the topics.
Part , Financial Management in Business, now offers a better introduction
to financial management. The characteristics of businesses are explained;
the basic terminology and principles are introduced; the finance and
accounting disciplines and basic financial statements are explained. After
studying the first part, students may study the other parts of the book in any
order. The other parts discuss the topics of finance, management accoun-
ting and financial accounting.

With regard to topic selection, we have been guided by the needs of the
target group. Some topics that were included in the first edition have been
deleted and other topics have been added on the basis of comments made
by users of the book, both students and professors.

The book is accompanied by a separate Exercises book and a website, which

contains updated additions and extra training and exercise material.

In this edition the team of authors has been reinforced by Olaf Leppink.
He is primarily responsible for the Exercises book and digital support resources.

We hope this publication fully meets the needs and wishes of all users.
Any comments or suggestions are warmly welcomed.

The authors
Teteringen, Zwolle
Spring 
© Noordhoff Uitgevers bv

Table of contents

Introduction  4 The business plan 

. Businesses based in Europe:

PART 1 facts and figures 
. Purposes of the business plan 
Financial management in . Components of the business plan 
business 
PART 2
1 Businesses and their role Finance 
in the economy 
5 Capital budgeting 
. Consumers and manufacturers 
. Profit and non-profit organizations  . Capital budgeting projects and cash
. Business activities  flow 
. Legal forms of businesses  . Assessment on the basis of
. Value added tax  profitability 
. Forms of association between . Assessment on the basis of cash
businesses  flow 
. Assessment on the basis of cash flow
taking into account the time value of
2 Financial management  money 
. Leasing 
. Financial management
disciplines 
. Relationships with other 6 Working capital
disciplines 
. Job opportunities in financial
management 
management 
. Inventory management 
. Credit management 
3 Financial statements  . Cash management 

. Investment and finance 

. Balance sheet and profit and loss
account 
. Profit vs. cash flow 
 © Noordhoff Uitgevers bv

7 Equity  PART 3

. Equity in businesses with non-legal
Management accounting 
entity status 
. Equity in businesses with legal entity 11 Costs 
status 
. Value of shares  . Fixed and variable costs 
. Reserves  . Cost-volume-profit analysis 
. Share issue  . Indifference point 

8 Liabilities  12 Costing 

. Price of liabilities  . Absorption costing 

. Bank loans  . Direct costing 
. Bonds  . Costs and decision making 
. Short term liabilities  . Economic lifespan and replacement
. Provisions  of fixed assets 

9 Financial statement 13 Cost allocation 

analysis  . Dangers of incorrect cost
allocation 
. Ratio analysis  . Process costing 
. Profitability ratios  . Overhead application rates 
. Solvency ratios  . Cost centres 
. Liquidity ratios  . Activity based costing 

10 Financial markets  14 Budgets and variance

. Investing in securities 
analysis 
. Options on shares 
. Futures  . Budgets 
. Investment ratios  . The master budget 
. Variance analysis 
© Noordhoff Uitgevers bv

PART 4 18 Inter-corporate
Financial accounting  investments 

15 External reporting  . Investments 

. Consolidated financial
. Publication of annual reports  statements 
. Financial reporting principles 
. Components of the annual Answers to test questions 
report 
Answers to multiple choice
questions 
16 Financial statements 
Credits 
. The balance sheet 
. The profit and loss account  Index 
. Valuation 

17 Cash flow statement 

. Function and status 

. Preparing the cash flow
statement 
8 © Noordhoff Uitgevers bv

Introduction

Basics of Financial Management covers all the topics that are relevant to
professions in which a basic knowledge of financial management is needed.
The course book is also suitable for students wishing to subsequently
undertake more in-depth study.

To promote the user-friendliness of the book, we have provided a brief

explanation of its structure and potential uses below.

The book is split into four parts:  Financial Management in Business,

 Finance,  Management Accounting and  Financial Accounting.
The first part provides an introduction to some basic terms and principles
of financial management. Readers are advised to start with this part.
With this knowledge the other three parts can be studied independently.
To support those students who wish to study a specific topic, for example
because they are enrolled in a problem-based or project-based course,
a diagram, mapping out the relationships between the chapters, has been
included in this introduction. This diagram is designed to help students
assess whether knowledge of other chapters is required before starting on
a chapter or topic. A detailed table of contents and an index have also been
included to enable topics to be easily searched.

The study material has been presented in such a way that students should
be able to learn the theory independently. To aid self-study, numerous
practical examples and test questions have been included in the text, so that
students can assess whether they have understood the material. To illustrate
its practical relevance, newspaper cuttings, parts of annual reports and
photographs with accompanying text have also been included.
Key terms are shown in the margin to emphasise their relevance. Each
chapter is concluded with a glossary and multiple-choice questions.
Answers to the multiple-choice and test questions are included at the back
of the book.

We recommend the testing of your knowledge with the use of the separate
Exercises book and additional exercises from the Basics of Financial
Management website, which is regularly updated and supplemented by
the publisher.
© Noordhoff Uitgevers bv 9

Part 1 Financial management in business

1 Businesses and
their role in the
economy
3 Financial 4 The business
statements plan
2 Financial
management

Part 2 Finance Part 3 Manage- Part 4 Financial accounting

ment accounting

5 Capital
budgeting 11 Costs
15 External
reporting

9 Financial
6 Working capital statement
management 12 Costing
analysis
16 Financial 17 Cash flow
statements statement

10 Financial 13 Cost
7 Equity markets allocation

18 Intercorporate
investments
14 Budgets
8 Liabilities and variance
analysis

Flexible learning pathways

It should be clear that the study of this course book can be approached in
various ways. We suggest some ‘learning pathways’ that will cover all the
material contained in this book. The first pathway follows the structure of
the book, first studying Finance, then Management Accounting and lastly
Financial Accounting. The authors have chosen this order to reflect the
successive problems facing start-up entrepreneurs.
In the second main pathway, Management Accounting is studied before
Finance and Financial Accounting. This is the more traditional order.
In principle, after the introductory part, one could start with Financial
Accounting. However, this is an unusual approach, although the structure of
the book allows it.
© Noordhoff Uitgevers bv 11

PART 1

Financial
management
in business
1 Businesses and their role in the economy 15

2 Financial management 43
3 Financial statements 57
4 The business plan 77
 12 PART 1 FINANCIAL MANAGEMENT IN BUSINESS © Noordhoff Uitgevers bv

Financial management is focused on financial aspects of running a

business. Businesses behave in an economic way: they try to realize
their goals by acting as efficiently as possible. Businesses produce
goods and services. Assets are used in the most effective and efficient
way to produce these goods and services.
Organizations striving for profit are called businesses, companies or
enterprises. In this book the terms business and company are both used
to illustrate financial management techniques. Most techniques can
also be applied in non-profit organizations.
In chapter , we take a closer look at businesses. We will discuss types of
business activity, distinguishing in particular mining and agriculture,
manufacturing, trading, and the services sector. The type of activity a
business is engaged in determines which assets it must invest in and the
cost structure. Businesses can also be classified according to their legal
form. When starting a business, one has to choose a legal form. The
business may be a sole proprietorship or, for instance, a limited liability
company. The financial consequences of this choice may be far-reaching:
the amount of tax the company has to pay on its profits is just one
example of the consequences. In chapter  we will also highlight some
forms of association between businesses, including mergers and
takeovers.
In chapter , we will discuss the three distinct disciplines within the
broad area of financial management. Finance is focused on business
investment in assets and the financing of these assets. Management
accounting deals with the provision of financial information to the
management of the business. The information has to enable
management to take the right decisions. Important topics in
management accounting are cost accounting and budgeting. Financial
accounting is concerned with the disclosure of financial information to
external stakeholders, such as shareholders and employees. The annual
report plays an important part in this disclosure. In chapter  we also
look at job opportunities in financial management.
© Noordhoff Uitgevers bv 13

Chapter  explains two types of financial statement used to describe the

financial position of a business. The balance sheet lists the assets a
business owns and the capital that is used to finance those assets.
The profit and loss account lists revenues and costs over a period,
resulting in a profit or loss. The financial statements are the most
important part of the annual report of a business.
If one wants to start a business, one needs a good plan. Chapter 
discusses the business plan, which is a summary of the entrepreneur’s
aims. Which activities will the business develop, who are its customers,
what are its unique selling points? These are marketing questions. The
entrepreneur will also have to make financial plans: what investments
are necessary, how should they be financed, what revenue will be
generated and what will be the costs? The financial elements of the
business plan result in a projected balance sheet and profit and loss
account.
14 © Noordhoff Uitgevers bv
© Noordhoff Uitgevers bv 15

1 1

Businesses and
their role in the
economy

. Consumers and manufacturers

. Profit and non-profit organizations
. Business activities
. Legal forms of businesses
. Value added tax
. Forms of association between businesses

A business can be defined as a profit-based production organization. Section . highlights

the elements that make up this definition. The essential differences between businesses and
non-profit organizations are outlined in section .. This section is intended to clarify that
most business techniques can also be applied to non-profit organizations.
In section . four types of business activity are discussed: agriculture and mining,
manufacturing, trading, and service. Businesses need a legal form to enable them to exist.
The choice of legal form is important for the liability of the owner(s) and for their fiscal
position. In section . the most common types of legal form are highlighted. Section
. explains value added tax; this is a tax all businesses in Europe have to deal with.
The different ways in which businesses can collaborate is the topic of section ..
 16 PART 1 FINANCIAL MANAGEMENT IN BUSINESS © Noordhoff Uitgevers bv

§ 1.1 Consumers and manufacturers

People need many things to live comfortably: a house, food, a car or a bike,
help with submitting their tax returns, relaxation (weekend breaks) and so
on. All these goods and services need to be ‘manufactured’. Car manu-
1
facturers supply our cars, while hotels allow us to relax on our weekend
break. Before the advent of the large-scale barter economy, consumers were
also manufacturers: they baked their own bread or built their own houses.
In our developed economy, this is no longer the case.
Manufacturing companies manufacture goods and services, which are then
sold on to the consumer. The consumer, in turn, has the requisite
purchasing power, as he is employed by a manufacturing company.
Economics is concerned with all issues relating to man’s quest for ‘prosperity’:
how can goods and services be offered as efficiently as possible, i.e. using as
few resources as possible.
Economics Economics is concerned with consumer–manufacturer and manufacturer–
manufacturer relationships. A distinction is made between micro- and
macro-economics. Micro-economics seeks to analyze – among other things –
market forms: how are the prices in any given market, for example the world
travel market, determined? The essential factor is supply and demand.
Section . briefly describes the different market forms. Macro-economics,
conversely, is concerned with the economic problems that affect society as
a whole, such as inflation and unemployment.
Financial Financial management is concerned with the economic activities within a
management production organization. It takes a very broad interpretation of the term
‘production’, denoting not only the production of physical goods, but also
trade and the provision of services.
Consequently, the car manufacturer is only one of many production
organizations. The car trader and the car mechanic, offering a repair
service, are production organizations as well. Section . discusses the
different types of production in more detail.
The economic system assigns an important role to production in businesses.
A business can be defined as an economic unit that aims to sell goods and
services to customers at prices that will provide an adequate return to its
owners. In other words: businesses are production organizations that are
specifically geared towards generating income in the marketplace
(they strive for profit).
We shall now focus on the two main elements that define the concept of a
‘business’.

A business is a production organization

A production organization combines production resources and transforms
them into end products (the production process). In other words, a
production organization operates between two markets: production
resources are acquired in the procurement market, and the manufactured
goods are sold in the sales market.
Production resources may consist of natural resources/raw materials on the
one hand and buildings, machines, etc. on the other. The latter are called
fixed assets or long-term assets, because they last longer than raw materials.
Asset Assets are economic resources. Anything tangible or intangible that is held
to have positive economic value is considered an asset. Of course, the
company’s workforce is a production resource as well.
© Noordhoff Uitgevers bv BUSINESSES AND THEIR ROLE IN THE ECONOMY 17

Figure . represents the production process in diagrammatic form.

FIGURE 1.1 Production process

1
Production process

Raw materials
Procurement Fixed assets Sales
market Finished products market
Labour

Cash

EXAMPLE 1.1
A brewery purchases malt, hops and water and processes them into beer. The water, the
malt and the hops are the raw materials used for the end product: beer. In addition to raw
materials, the company also needs fixed assets: business premises, vats in which to
prepare the beer, lorries to transport it, computers, etc. Employees are of course also
a vital chain in the link.

The organizational structure of the business can be formal, setting out the
rights and obligations of the participants: the powers and responsibilities of
shareholders, managers and employees are laid down in the articles of
association and job descriptions. A production organization can, however,
also consist of a group of students starting a courier service and agreeing
only to take turns in answering the phone or delivering products on a
scooter.

TEST QUESTION 1.1

The owner(s) and employees are the direct participants in the business.
Broadly speaking, we can identify more than two participants with an
interest in the success of the business.
Name three other participants.

Businesses strive for profit

Businesses participate in the economic process for ‘self-improvement’.
They strive to ‘create value’: the net proceeds from the sale of the
manufactured goods or services must outweigh the price paid to the
procurement market for the production factors (labour, raw materials, fixed
assets). This surplus, the profit, is awarded to the business owners.
The amount of profit depends on efficiency on the one hand, and on the
effectiveness of the business process on the other.
The term efficiency relates to the cost of the production process. An efficient Efficiency
production process manufactures a given quantity of products with the least
possible costs.
Effectiveness relates to the purpose of the production process, i.e. the degree Effectiveness
to which the end product fulfils the requirements and wishes of the end
 18 PART 1 FINANCIAL MANAGEMENT IN BUSINESS © Noordhoff Uitgevers bv

buyer. An effective production process manufactures an end product that is

in high demand with customers, i.e. the customers are more than happy to
pay for it.

1
EXAMPLE 1.2
The brewery in Example 1.1 strives to produce a hectolitre of beer by deploying labour and
assets as efficiently as possible. The business will strive to keep its costs as low as
possible. Cost per unit is therefore a yardstick for efficiency.
The finished product must be of a sufficiently high standard to enable the business to gain
a share of the beer market.
The taste of the beer, the price:quality ratio and brand positioning (through advertising) are
contributory factors. The degree to which the brewery manages to generate sales revenue
determines the effectiveness of the business. The roles played by efficiency and
effectiveness in the production process are shown in Figure 1.2.

FIGURE 1.2 Efficiency and effectiveness in the production process

Input Transformation Output Realisation of

process objectives

Efficiency Effectiveness

Cost per unit Sales

Businesses characteristically use their profit figures as a yardstick for

measuring efficiency and effectiveness: after all, profit is the healthy
balance between sales (yardstick for effectiveness) and costs (yardstick for
efficiency).
Generating profit is the number one priority of a business; how this profit is
achieved is of secondary importance. For example, a shipping company that
no longer sees any profit potential in its shipping operations would in
principle have no problems turning its attention to another activity.
Although some employees will bemoan the loss of the company’s proud
shipping tradition, financial considerations have priority.
Profit is the ultimate objective; the company’s activities and operations are
purely a means to the end of generating profit.
When a shipping company concludes that the shipping business no longer
generates a profit, it should have no problem in switching to another type of
activity. Of course, some employees will regret the loss of a rich history of
shipping industry, but economical considerations come first.
The following factors must, however, also be taken into account:
• Generally speaking, entrepreneurs do not strive for profit ‘at any cost’.
Continuity The continuity of the business is equally important. For the company to
secure its future, it is essential that it generates profit; only then will the
business have the financial means to survive independently. To guarantee
 © Noordhoff Uitgevers bv BUSINESSES AND THEIR ROLE IN THE ECONOMY 19

the continuity of the business, it is essential that profit is viewed in a

long-term perspective: making ‘a fast buck’ by offering inferior products
as top quality will be counterproductive in the long run.
• Most businesses have a mission statement, which outlines their goals Mission
and philosophy. Profit is usually not a prominent objective, unlike statement
1
environmental factors, an enjoyable working environment, etc. Needless
to say, a mission statement can also be used to ‘show off’ to the outside
world.

easyJet.com

easyJet mission statement

To provide our customers with safe, good business markets on a range of European
value, point-to-point air services. To effect routes. To achieve this we will develop our
and to offer a consistent and reliable people and establish lasting relationships
product and fares appealing to leisure and with our suppliers.

• At times, it appears that striving to generate the highest possible profit is

secondary to striving to achieve the highest possible sales. For company
directors, the dictum ‘the bigger the better’ all too often rings true.
Businesses are taken over, despite an almost complete absence of any well
founded expectations that the business will generate additional profit.

§ 1.2 Profit and non-profit organizations

As businesses strive for profit, they are part of the profit sector.
This book concentrates mainly on the profit sector. However, there are also
a significant number of non-profit organizations. We can make a distinction
between ‘public’ and ‘private’ non-profit organizations.
• The public sector is arranged on three levels: national, regional and local. Public sector
The public sector is primarily concerned with providing public-sector
goods and services; these facilities are intended for the population as a
whole, such as infrastructure and safety. These facilities cannot be
provided by private enterprises due to the complete absence of market
mechanisms: after all, it is impossible for a consumer to construct a
motorway section for his own personal use. To provide public-sector
goods and services, it is essential to levy taxes to finance their production.
Certain facilities provided by the government could in principle also be
provided by businesses: in addition to government-funded schools,
private educational and training institutions exist.
In recent years, there has been a growing trend towards privatization: all Privatization
operations and activities deemed eligible for privatization are being freed
from government control and ‘let loose on the market’ to justify their
existence.
• Private non-profit institutions encompass a broad range of organizations,
ranging from amateur sports clubs to charities such as the Red Cross.
Organizations in the latter group are often classified as fund-raising
institutions, as they raise money to achieve certain social objectives.
 20 PART 1 FINANCIAL MANAGEMENT IN BUSINESS © Noordhoff Uitgevers bv

Organizations in the non-profit sector differ from businesses in a number of

respects:
• The objective of a non-profit organization is to achieve certain (socially
important) objectives. Its activities are inextricably linked with these
goals. The rationale of Médecins sans frontières, for example, is to offer
1
medical assistance in developing countries. This organization is not
interested in transferring to other activities out of financial-economic
considerations. Furthermore, its donors and supporters would object
strongly if the organization switched its attentions to other activities.
Conversely, the shareholders of a profit organization such as Unilever
would not bat an eyelid if the company decided to stop manufacturing
washing powder in favour of another activity that promises higher profit
and a higher rate of return.
• Ordinarily, non-profit organizations cannot exist by only conducting
market transactions and – in contrast to businesses – are consequently
not economically independent. They depend heavily on contributions,
donations, subsidies, legacies and so on. To some extent, non-profit
organizations are able to operate in the market, for example by selling
pre-printed T-shirts.
• Assessing the effectiveness of non-profit institutions is a lot more
complex than with businesses. As stated previously, the profit sector uses
profit figures to highlight efficiency and effectiveness. Profit figures have
no viable place in the non-profit sector.
A foundation aiding victims is effective only if it succeeds in rectifying the
problems of its clients. The degree of success achieved cannot possibly
be expressed in financial terms. An alternative method must therefore be
found to express the degree of effectiveness of such an organization, for
example measuring waiting times or conducting satisfaction surveys
among clients for the various services provided. On the other hand, it is
usually possible to measure the efficiency of non-profit institutions by
calculating the cost per service. A victim-support service, for example,
could calculate the cost of an hourly consultation.

The topics and methods discussed in Part  (Management Accounting) can

therefore also in part be applied to non-profit organizations, as they too
strive to operate as efficiently as possible.
Financial reports (discussed in Part , Financial Accounting) can also be
applied to non-profit organizations, on the strict understanding that profit
does not necessary imply that the organization has functioned well, as profit
is not the primary goal of the non-profit sector.
© Noordhoff Uitgevers bv BUSINESSES AND THEIR ROLE IN THE ECONOMY 21

YEARS ENDED 31 DECEMBER 2009 AND 2008

ALL AMOUNTS ARE THOUSANDS OF EUROS
This summary shows the total income and expenditure of all Greenpeace offices
(including Greenpeace International) worldwide.
Income and Expenditure 2009 2008 1
Income:
Other Grants and Donations 195,876 196,620
Interest 1,744 4,583
Merchandising and Licensing 150 (474)
Other Income 2,087 1,834
Total Income 199,857 202,563
Fundraising Expenditure 63,149 60,332
Net Income 136,708 142,231
Expenditure:
Campaigns:
• Oceans 7,365 9,479

• Forests 9,340 9,024

• GE 4,737 4,457

• Toxics 3,237 2,855

• Climate & Energy 27,506 22,962

• Peace & Disarmament 178 1,507

• Other Campaigns 2,234 1,225

• Media and Communications 18,870 17,829

• Marine Operations and Action Support 22,046 21,603

• Public Information and Outreach 11,434 9,474

• Political, Science and Business 2,045 1,736

Organizational Support 31,067 30,455
Foreign Exchange (Gain)/Loss (1,604) 3,355
Loss on Investments -- 5,537
Total Non-Fundraising Expenditure 138,456 141,498
(Deficit)/Surplus for the Year (1,748) 734
Opening Fund Balance 152,882 151,193
Direct Fund Balance Adjustment 800 955
Closing Fund Balance 151,934 152,882
Source: Greenpeace annual report 2009
 22 PART 1 FINANCIAL MANAGEMENT IN BUSINESS © Noordhoff Uitgevers bv

TEST QUESTION 1.2

The income of Greenpeace over 2009 was – €1,748,000. Why should we
not automatically conclude that 2009 was a bad year for Greenpeace?

1 § 1.3 Business activities

In section ., we defined a business as a profit-based production
organization. Businesses aim to generate profit by purchasing assets and
converting or transforming these assets into goods or services that are sold
for more than the original purchase price.

We can roughly classify businesses according to the nature of this

‘conversion process’:
• agriculture and mining
• manufacturing
• trading
• service.

FIGURE 1.3 Breakdown of value added, EU-27, 2008

(% share of total value added)

Agriculture,
hunting,
Construction forestry & fishing
6.4% 1.8%

Financial interm.;
Industry real est., rent. &
20.1% bus. activities
28.2%

Public admin. & defence;

Distrib. trades; educ.; health & social work;
hotels & rest.; other community, social &
transp., stor. & comm. personal services
21.0% 22.5%

Source: Eurostat Key figures on European business, 2010 edition

Agriculture and mining

Agricultural and mining companies typically use ‘natural’ resources. Using
relatively few raw materials, they manage to produce large quantities of
finished products. For example, the costs of purchasing sowing seed are
minimal compared with the proceeds from the sale of the harvest produce.
Mining companies extracting minerals such as gold, copper, gas and oil
make no use of raw materials at all. Needless to say, fixed assets are vitally
important to this sector: the farmer cannot function without farmland, and
the extractive industry cannot mine or extract oil without concessions;
machinery and heavy equipment are also important.
© Noordhoff Uitgevers bv BUSINESSES AND THEIR ROLE IN THE ECONOMY 23

Manufacturing
Manufacturing businesses create a physical, tangible product, which did not
exist in that form prior to the manufacturing process. We can make a
distinction between mass production and job production.
1
With job production, a ‘customised’ product is produced. Each product is Job production
tailored to the specific wishes of the customer. The product is ‘made to
order’: it is first sold and then manufactured. In other words, there is no
stock build-up of unsold finished product. A good example of job
production is a shipyard, building pleasure yachts to the customer’s
specifications.
Under the mass production (also called flow production) system, one type of Mass
product is manufactured in large quantities. Specific customers’ wishes are production
not taken into account. Products are manufactured for stock. A good
example is a sugar refinery.
The differences between job production and mass production are
summarized in table ..

TABLE 1.1 Differences between job and mass production

Job production Mass production

Customized design Standardized design
Made for one specific customer Made for the ‘market’
Made to order Made for stock

Between the two extremes (job and mass production), we can also identify a
‘hybrid’, namely batch production. Batch production is used to produce or Batch
process any product in batches. With batch production, varieties or models production
of one standard product are manufactured. A yacht builder, for example,
could generate considerable cost savings by manufacturing series of hulls,
masts and saloons, enabling the customer to design his own ‘dream boat’
using the available components.

The relevance of each of the three ‘inputs’ (raw materials, fixed assets and
human labour) depends on the type of company.
The costs of an oil refinery comprise mainly raw materials and fixed assets,
while a manufacturer of handmade wooden kitchens will predominantly
incur labour costs. As automation increases, the importance of fixed assets
will increase as a proportion of total costs.

Trading
Trading companies do not manufacture new products. In other words,
there is no transformation or conversion process in the technical sense.
The raison d’être of trading companies is the unequal relation between
production and consumption. The inequality can relate to:
 the scale of production and consumption
 the composition of production and consumption
 the point in time that production and consumption take place
 the place of production and consumption.
 24 PART 1 FINANCIAL MANAGEMENT IN BUSINESS © Noordhoff Uitgevers bv

EXAMPLE 1.3
A Japanese manufacturer of PCs will struggle to sell his computers directly to French
consumers. A computer chain store can purchase computers in bulk in Japan (1),
incorporate the products into its range, which is also of interest to the customer (2), hold
stock so that the customer can purchase the computer at any time (3) and offer his
1
products to consumers who live in the vicinity of the store (4).

The ‘transformation process’ of a trading company is therefore a

transformation according to size, range, time and place.
Wholesale We can make a distinction between wholesale trading and retail trading.
trading The retail trader is the last link in the chain; he supplies directly to the end
Retail trading user of the goods, the consumer. Wholesale traders, conversely, purchase
from the manufacturer and distribute the purchased products to retail
outlets. The wholesale trade is a classic case of business-to-business
trading: both the suppliers and the customer are companies. In order to
establish an independent function in the production chain, wholesale
traders must ensure in particular that the right products reach the stores at
the right time. This requires major investment in logistical systems.
The costs of a trading company primarily comprise the purchased
merchandise. This type of business also uses fixed assets (business
premises, cars, vehicles, etc.). The costs of labour can also be considerable,
in particular in the retail trade.

Service
Service companies provide a service to their customers, without
manufacturing a new product or transforming an existing product.
This sector can be broken down into a variety of business categories,
including:
• financial services (banks, insurance companies)
• hospitality and catering
• haulage
• ICT services (software firms, computer consulting firms)
• general and technical support services (security, catering, cleaning).

Service companies typically make little (or no) use of raw materials.
However, fixed assets are vitally important to certain service companies, for
example a hotel located in the heart of Brussels, or a shipping company with
a fleet of container ships.
Labour is virtually always an important cost item; the service sector is a
‘people business’: an IT consultancy depends on its IT professionals, a
security company depends on its guards.
 © Noordhoff Uitgevers bv BUSINESSES AND THEIR ROLE IN THE ECONOMY 25

In container shipping, fixed assets cause
large costs. It takes about €150 million to
build a large container ship. Labour costs
are high as well. By using larger ships,
shipping companies try to minimize labour
costs. In principle, a large ship does not
need more crew than a small ship. So, the
labour costs per container are smaller with
a large ship. The biggest container ships
can carry about 14,000 containers. Due to
automation, 13 crew suffices.
The Danish shipping company APM-Maersk
controls most of the container shipping
market. The company’s ships have a joint
capacity of more than 2 million containers.

TEST QUESTION 1.3

Below are the cost ratios of three companies:

1 2 3

Costs of raw materials 15% 48% 0%

Personnel costs 39% 19% 59%
Depreciation costs on fixed assets 5% 4% 3%
Other costs 41% 29% 38%

The three companies are:

• A steel manufacturer
• A manufacturer of hand-painted tiles
• A business consulting firm

Which figures relate to which company?

§ 1.4 Legal forms of businesses

All businesses have a legal form. The choice of legal form determines the
legal relationships within the business and between the business and the
outside world.
 26 PART 1 FINANCIAL MANAGEMENT IN BUSINESS © Noordhoff Uitgevers bv

The legal form determines the following:

• who has the ultimate say in the business
• what guarantees are in place to ensure the long-term continuance of the
business
• in what ways the business can attract funds and financial resources
1
• to what extent the business owners are liable for the debts incurred by the
business
• the tax position of the company
• to what extent the business is obliged to disclose its financial results.

In some legal forms, the business – rather than its owners – is considered
the prevailing party in any commercial legal agreement. In these cases, the
Legal entity business is an independent legal entity or ‘legal person’.
The business hires staff in its own name, concludes sales contracts and
borrows money from the bank. Of course, the business needs people
(‘natural persons’) to conduct these activities on its behalf.
If the business is not the legal person, the agreements will be concluded in
the name of the owner/proprietor.

In the next sections, we will discuss the most commonly used legal forms:
Non-legal entity status:
• sole proprietorship
• partnership
Legal entity status:
• joint-stock company.

Sole proprietorship
In a sole proprietorship there is no separation between the owner and the
manager. A sole proprietorship stands and falls with the entrepreneur; if the
entrepreneur decides to cease operations, the company disappears with
him. In other words, the long-term continuance of the business is uncertain.
If the entrepreneur ceases activity or is unable to continue operating, a
successor must be found, either in his immediate family or elsewhere.
The business can be financed using funds that the owner is prepared to
invest in his company, or through loans. The first finance option is known as
Equity equity, the second as liabilities or debt. A sole proprietorship will typically
Liabilities be small, as the available equity will be modest. When starting up his
business, the owner will need to invest a percentage of his own money
(‘private capital’) in it; he can strengthen the financial position of his
business by retaining profits, i.e. by not using them for private purposes but
retaining them in the business.
A sole proprietorship has no legally separate existence from its owner, and
legal agreements are concluded in the owner’s name. The owner is liable for
any debts arising from the operation of his business.

EXAMPLE 1.4
An entrepreneur has invested his savings in a hairdressing business. He borrows the
remainder of the required capital from his bank. The business fails to attract enough
customers. The entrepreneur is struggling to keep up with his payment obligations
(interest and capital). He decides to sell his chairs and equipment, but the proceeds are
minimal. In order to repay the bank loan, the entrepreneur is obliged to use private means.
If necessary, he may be forced to sell his car or house.
© Noordhoff Uitgevers bv BUSINESSES AND THEIR ROLE IN THE ECONOMY 27

The owner of a sole proprietorship pays income tax on the profit he makes Income tax
from the operation of his business.
The regulations on income tax vary per country. Income tax may be a flat
tax, which means that everyone pays the same percentage of their income
to the government. In most countries, however, income tax is a progressive Progressive tax
1
tax, in which people with higher incomes pay higher percentages. For
example, someone who makes €, per year pays a higher percentage,
called a marginal tax rate, than someone who makes €,. However,
it is important to note that the marginal tax rate does not increase for one’s
entire income, merely for each euro over a certain threshold. Suppose one
pays % of one’s income up to €,, and % thereafter. Someone
making €, does not have to pay % on his entire income, merely on
the € over €,. That is, he owes % of €, and % of the €
over that.
Income tax is calculated on the basis of adjusted gross income: gross income Adjusted gross
less allowed personal and business-related deductions such as alimony income
payments, health-related expenses and pension contributions. In many
countries, incentives in the form of additional deductions are offered to
encourage entrepreneurship.
Sole proprietorships have no obligations to publicly disclose financial
information.

Partnership
In a partnership, two or more people decide to operate a business.
The company is run and managed by the partners. The advantage of a
partnership is that both parties can ‘invest’ their specific expertise, and
reach better decisions through mutual consultation. The flip side of the coin
is that ‘too many cooks may spoil the broth’ because of differences of
opinion. This may of course have implications for the continuity of the
company. On the one hand, the company’s continuance need not be
jeopardised if either party decides to leave the partnership; on the other,
disagreements can result in the premature closure of the business.
Generally speaking, partnerships have more opportunities to acquire equity
than sole proprietorships, as a new partner can ‘buy into’ the partnership.
In a general partnership each partner is, jointly and severally, liable for the
debts of the partnership; in other words, a creditor can oblige both partners
to repay the debt.

EXAMPLE 1.5
Steptoe and Son trade in antiques and curiosities. Father and son each have a 50% stake
in the partnership. The partnership has purchased oriental antiques from an importer for
€30,000. The invoice has not yet been paid.
Due to the economic slowdown, Steptoe and Son only manage to sell this stock for
€18,000. The partnership has no other assets that can be converted into cash.
The importer is entitled to demand that father Steptoe pay the remaining €12,000.
Father Steptoe will now need to find ways to ensure that his son pays him half of the
outstanding debt.
 28 PART 1 FINANCIAL MANAGEMENT IN BUSINESS © Noordhoff Uitgevers bv

Limited A partnership can also consist of limited partners. In contrast to general

partners partners, limited partners are not obliged to pay the debts of the
partnership. Their liability is limited to the amount they invested in the
partnership. A person can only be a limited partner on the condition that
(s)he does not participate in the management of the partnership; a limited
1
partner is therefore solely a ‘financial backer’.

A partnership is transparent for tax purposes: the partners owe income tax
on the share of the profit from the partnership.
A partnership is not obliged to publicly disclose financial statements.

The so-called man-and-wife company is a €100,000 is higher than on two incomes of

much-used tool to avoid taxes in a
progressive income tax system. If an
entrepreneur (who first owned a sole-
proprietorship business) takes his or her
spouse or partner into the company, forming
a partnership, each of them receiving 50%
of the profits, the total amount payable in
income tax is reduced. Both partners are
entitled to business-related deductions and
(as a result of the progressive taxation
system) taxation on one income of, say,
€50,000.
The tax authorities do take a critical look at
man-and-wife companies. If a dentist takes
his wife – who acts as his assistant – into
the company, they will argue that such a
company is ‘uncommon’. After all, the
company depends on the work of the
dentist; it is he who decides on policy. In
view of the imbalance in the work, the
authorities will not recognize this type of
man-and-wife company as a partnership.
© Noordhoff Uitgevers bv BUSINESSES AND THEIR ROLE IN THE ECONOMY 29

Joint-stock companies
Joint-stock companies are legal entities; as we have seen earlier, they can
conclude agreements in their own name.
We can identify two types of joint-stock company: the limited liability
1
company (LLC or Ltd) and the public limited company (PLC). We shall LLC
discuss the shared characteristics of the two business forms, before PLC
focussing on the differences.

The equity of joint-stock companies is divided into shares. The shareholders Shares
are the owners of the joint-stock company. A board of directors is
responsible for the day-to-day running of the business.
A joint-stock company can increase its equity if the meeting of shareholders
decides not to pay out any profits, but to retain the profit. It may also decide
to issue shares.
This type of business tends to be more secure than the sole proprietorship
and partnership, as ‘management’ and ‘ownership’ are separated.
Shareholders are not personally liable for repaying the debts of the joint-
stock company; their risk is limited to the value of their share holdings.

The fiscal position of the joint-stock company is rather complicated as there

are two taxes involved.
Joint-stock companies are liable for corporate tax on their profits.
The shareholders, in turn, pay income tax on the dividends they receive
following profit distribution.
Individual countries use different systems with regard to the levying of
corporate tax and income tax on shareholders.
There are two main systems: the classical tax system and the imputation tax
system.
The classical system of corporation tax is a system of taxing companies in Classical
which the company is treated as a taxable entity separate from its system
shareholders. The profits of companies under this system are therefore
taxed twice: first when made by the company and again when distributed to
the shareholders as dividends.
Under an imputation system, taxes paid by a corporation are considered as Imputation
paid on behalf of its shareholders. The tax paid by the corporation is system
credited against the tax liability of the shareholder. Thus, imputation
systems eliminate re-taxation of the distributed profits of a corporation.
We shall illustrate these systems in example ..

EXAMPLE 1.6
Joint-stock company A has recorded a profit of €1,000,000. All profit after taxation is paid
out to its shareholders. The rate of corporate tax is 25%, and income tax is 50%.

Classical tax system

Under this system, corporate tax and income tax are levied separately.
€250,000 in tax is levied on joint-stock company A; the profit after taxation is €750,000.
This is paid out as dividends; in total, €375,000 income tax is levied on the shareholders.
The total tax burden on the profit is therefore:

(€250,000 + €375,000)/€1,000,000 = 62.5%.

 30 PART 1 FINANCIAL MANAGEMENT IN BUSINESS © Noordhoff Uitgevers bv

Imputation tax system

Under this system, tax is levied once only on the profit. Although €250,000 tax is levied on
joint-stock company A, this is not a separate levy, but a prepayment against the income tax
to be paid by the shareholder.
€1,000,000 is attributed to the shareholders as dividends. A total of €500,000 income
1
tax is levied. However, the corporate tax of €250,000 can be set off against income tax,
so that the total income tax bill for the shareholders is €500,000 less €250,000 =
€250,000. In effect, shareholders are credited for the tax suffered by the company on
its income.
Under this system, the total tax burden is 50%, namely the income tax.

Within the EU, the imputation system is used in most countries. The
Netherlands uses the classical system.
The following should be noted with regard to taxation:
• Most countries try to strike a ‘tax burden balance’ between companies
that are not run as legal entities and those that are. This harmonization is
achieved ‘automatically’ under the imputation system.
• We can also identify a third type of tax levied on joint-stock companies:
dividend taxation. This does not increase the tax burden, as it is treated as
an ‘advance levy’ in respect of income tax. In other words, the sharehol-
ders can offset any dividend tax against their income tax.

CORPORATE TAX RATES IN WESTERN EUROPE (2009)

Belgium  33.99
Denmark  25
France  33
Germany  15
Greece  20/25
Ireland 12.5/25
Italy  3.9/27.5
Luxembourg  21
Netherlands  20/23/25.5
Norway  28
Portugal  20/25
Spain  30
Sweden  26.3
Switzerland 8.5
United Kingdom  28
 © Noordhoff Uitgevers bv BUSINESSES AND THEIR ROLE IN THE ECONOMY 31

Joint-stock companies are required by law to publish an annual report, the

main components of which are the financial statements: the balance sheet
and the profit and loss account.

Differences between limited liability companies and 1

public limited companies
In general – legislation differs from country to country – public limited
companies (PLCs) tend to be companies that trade their shares on the stock
exchange. The shares can be traded on a daily basis and the market price is
continually known. The articles of incorporation thus pose no restrictions
on the transfer of shares from one shareholder to another. PLCs must also
satisfy the statutory minimum share capital requirements.
Limited liability companies (LLCs), conversely, may have only one
shareholder, usually the managing director. Sole proprietors often decide to
become a limited liability company due to the tax advantages and the
liability aspect.
The list below gives the names of LLCs and PLCs in various countries:

LLC PLC
Netherlands Besloten vennootschap met beperkte aansprakelijkheid (BV) Naamloze vennootschap (NV)
Germany Gesellschaft mit beschränkter Haftung (GmbH) Aktiengesellschaft (AG)
France Société à responsabilité limitée (SARL) Société anonyme (SA)
Spain Sociedad Limitada (S.L.) Sociedad Anónima (S.A.)
Italy Societa a responsabilita limitata (Srl) Societa per Azioni (SpA)
Denmark Anpartsselskab (ApS) Aktieselskab (A/S)
USA Limited liability Company (LLC or Co. Ltd) Corporation (Corp.) or Incorporated
(Inc.)
Japan Godo kaisha (G.K.) Kabushiki kaisha (K.K.)

§ 1.5 Value added tax

In section . – where legal forms of business were discussed – taxes that are
levied on the profit a company has made were also discussed. For non-legal
entities income tax is applicable and for legal entities corporate tax applies.
In this section we discuss value added tax (VAT), a tax that every business in VAT
Europe and in most other countries in the world – regardless of its legal
form – is confronted with. Value added tax is a tax that is levied on
consumer spending. The final buyer of a commodity or a service has to ‘foot
this tax bill’.
In order to achieve this, a system of taxation on added value is applied. Each
time a company makes a sale, it has to increase the selling price with value
added tax, which the company has to pay to the tax authorities. Every
country in the EU has its own percentage(s) of VAT and these percentages
may be changed from time to time.
 32 PART 1 FINANCIAL MANAGEMENT IN BUSINESS © Noordhoff Uitgevers bv

The tax is payable irrespective of whether the buyer is a consumer or

another company. When the buyer is a company, he is entitled to reclaim
from the tax authorities the VAT that was passed on to him. When the buyer
is the final consumer, he does not have this right of reclamation and he is
‘stuck’ with the tax.
1
Sales tax Outside Europe a sales tax is sometimes levied instead of VAT. For example,
this is the case in the US. Sales tax differs from VAT in that it is levied only at
the final sale to a consumer, not at earlier stages in the trading process. For
the consumer this does not make much difference. In the end he has to pay
the tax. The biggest difference is obviously for companies that do not sell to
consumers. They don’t have to bother with sales tax.

EXAMPLE 1.7
Company X extracts raw material and uses it to manufacture a product. The total costs of
the product are €100 per unit. Company X sells the product to a wholesale trader for €150
per unit. The wholesale trader sells the product to a retailer at a price of €170 per unit and
in turn the retailer sells the product to consumers at a price of €200 per unit.
The percentage of VAT is 19%.

When company X sells one product to the wholesale trader VAT at 19% of €150 has to be
paid. The selling price including VAT is therefore 1.19 × €150 = €178.50. Company X pays
19% × €150 = €28.50 to the tax authorities.

The selling price of the wholesale trader is €170. At the sale of the product by the
wholesale trader to the retailer the selling price including VAT amounts to 1.19 × €170 =
€202.30. The wholesale trader owes the tax authorities the difference between the
received VAT and the paid VAT per unit: €32.30 – €28.50 = €3.80.

The selling price of the retailer is €200. Including VAT the selling price is 1.19 × €200 =
€238. The retailer has to pay €38 – €32.30 = €5.70 to the tax authorities.

Table 1.2 summarizes the above:

TABLE 1.2 Consequences of VAT for businesses

Selling price VAT to be paid VAT to be received Net price Profit

including VAT
Manufacturer
Cost of goods sold €100 €100
Selling price €178.50 €28.50 €150 €50
Wholesale trader
Purchase price €178.50 €28.50 €150
Selling price €202.30 €32.30 €170 €20
Retailer
Purchase price €202.30 €32.30 €170
Selling price €238 €38 €200 €30
Consumer
Purchase price €238 €238
© Noordhoff Uitgevers bv BUSINESSES AND THEIR ROLE IN THE ECONOMY 33

Table . shows the following:

• VAT does not raise costs for a company. VAT owed to the tax authorities is
transferred to the buyer and VAT paid to suppliers is reclaimed from the
tax authorities.
• In the presentation of the profit and loss account, VAT plays no part.
1
Revenue and costs are presented excluding VAT.
• In the end the consumer pays all levied VAT on products and services.
VAT is a consumer tax.

TEST QUESTION 1.4

Under what circumstances will a negative VAT balance cause the company
to receive VAT from the tax authorities?

Special situations
• Reduced rate
A reduced rate of VAT is levied on the sale of some goods and services,
including some food products, medicines, and theatre and sports tickets.

• Exemptions
A number of goods and services are exempt from VAT, including
educational, medical and cultural services. Organizations in these lines
of business face two consequences:
 They do not need to raise the selling price with VAT and therefore do
not pay VAT to the tax authorities.
 They cannot reclaim paid VAT to suppliers.

EXAMPLE 1.8
A company called Living specializes in organizing cultural events. In April a customer is
charged €500 and Living receives a bill for €1,500 plus €285 VAT for repairs to its
building.
Cultural services are exempted from VAT, so Living does not have to include VAT in its
selling prices. The customer just pays the net amount of €500. Living cannot reclaim the
VAT amount of €285 it paid to its supplier.

• Export
Value added tax is a consumption tax and is therefore levied in the
country where the customer lives. So, sales of services to other
businesses or private customers are charged VAT where the customer is
based, not where the supplier is established.

EXAMPLE 1.9
Dutch trading company ‘Golden Oak’ buys wooden furniture from Dutch manufacturers and
exports them to Germany. Golden Oak buys furniture at €10,000 plus €1,900 VAT.
A German customer is charged €10,000.
Golden Oak can reclaim the paid €1,900 VAT from the Dutch tax authorities. The delivery of
goods to the German customer is charged a net selling price excluding VAT. The German
customer has to pay VAT to the German tax authorities.
 34 PART 1 FINANCIAL MANAGEMENT IN BUSINESS © Noordhoff Uitgevers bv

§ 1.6 Forms of association between businesses

To a greater or lesser degree, businesses may wish to establish some form of
collaboration with other businesses. In return, they relinquish (part of ) their
independence. Their competitors have effectively turned into colleagues.
1
We will discuss three types of association: mergers and takeovers,
franchising, and cartels.

Mergers and takeovers

Any business that wants to grow will need to engage in new activities.
However, sometimes it is easier to accomplish growth by absorbing another
company than by growing on one’s own (autonomous growth). A takeover
or acquisition is typically achieved by acquiring a controlling interest in the
target company, by purchasing the majority of its shares. A merger is the
combination of two companies in order to gain mutual benefits. In this case
there is no acquirer and no target, but two equal partners.
The relationship between the involved companies in a merger or takeover
can differ. We will illustrate this by means of the company’s position in the
production process.

We can identify the following types of merger or takeover:

Industry  The businesses operate in the same industry. An industry is a division of
a market sector and includes companies producing the same or similar
goods and services. These companies often compete with each other for
customers. When one chain of petrol stations acquires another chain,
competition is reduced and cost savings may be realized, e.g. by
obtaining larger discounts on the purchase of oil products.
 The businesses operate at different stages of the production process.
Vertical This is called vertical integration. When a chain of retail stores acquires
integration the manufacturer of its products, this is called backward vertical
integration: acquisition takes place towards the source. A dairy farm
cooperative acquiring a cheese-processing plant is an example of
forward vertical integration. See figure ..

FIGURE 1.4 Vertical integration

Backward Forward

Dairy Farming
Primary Cooperative

Secondary Cheese Processing

Manufacturer Plant

Tertiary Retail stores

© Noordhoff Uitgevers bv BUSINESSES AND THEIR ROLE IN THE ECONOMY 35

In the oil business the big five oil companies (BP, Chevron, Conoco-
Phillips, ExxonMobil and Shell) control all stages of the production
process, from nodding donkey to gas station.
 Acquirer and target operate at the same stage of the production process
but in different industries, e.g. a confectionery manufacturer taking over
1
a soft drinks manufacturer. This is called horizontal integration. Horizontal
 Acquirer and target operate in different lines of business. This is called integration
conglomerate acquisition. In the past, many conglomerate companies Conglomerate
were formed, operating at different stages in different industries. acquisition
The objective of these companies was risk reduction. Nowadays, such
conglomerate businesses are no longer popular, because they turned out
to be very hard to control by one centralized management. The present
trend is to go back to core business: companies focus on core activities
and sell non-corresponding departments.

Franchising
Under the franchising formula, a sole proprietor affiliates with a chain and
is granted access to certain facilities such as the company name, purchasing
system, marketing operation and store design and layout services.
For the franchiser, it is particularly important that the sole proprietor knows
the local market well. The franchisee, meanwhile, remains a sole proprietor,
although ‘the outside world’ perceives the franchisee as a branch manager.
The franchisee pays a fee – usually in the form of a percentage of sales – to
the franchiser for the facilities placed at his disposal.
 36 PART 1 FINANCIAL MANAGEMENT IN BUSINESS © Noordhoff Uitgevers bv

In 1940 the brothers Dick and Mac
McDonald opened McDonald’s Bar-b-que
restaurant on Fourteenth and E streets in
San Bernardino, California. After WWII the
introduction of the Speedee Service System
1
established the principles of the modern
McDonald’s formula. Ray Kroc, a milkshake
machine representative, advised the
brothers to open more restaurants. Today,
McDonald’s operates more than 31,000
restaurants worldwide. Each restaurant is
run by a private owner under a franchising
formula. If you want to own a McDonald’s
you will need private savings of at least
€250,000. In exchange, you can use the
McDonald’s name, logo and recipes. You will
have to pay a percentage of your sales
revenue to McDonald’s.

Cartelization
Under cartelization, independent companies draw up agreements that are
designed to restrict competition. The opportunity to make such agreements
is dependent on the market in which the businesses operate.
Competitive In a competitive market, there are a multitude of companies offering a
market standardized product to a multitude of customers. This is an intensely
Monopoly competitive environment. At the other extreme is the monopoly: there is
only one market player, and no competition.
Neither of these market forms provides an ideal basis for cartelization.
Oligopoly An oligopoly is defined as a market dominated by a few large suppliers.
A good example is the road construction industry. In an oligopoly,
businesses can be tempted to make agreements on selling prices.
They may even go as far as to ‘distribute the market amongst themselves’.
This is a classic case of cartelization. As cartelization tends to disadvantage
consumers, the European Union has identified the counteracting of any
cartelization tendencies as a key priority.

TEST QUESTION 1.5

Name two examples of sectors in which an oligopoly applies.
© Noordhoff Uitgevers bv 37

Glossary
1

Business An economic unit that aims to sell goods and services to

customers at prices that will provide an adequate return to its
owners.

Cartel An agreement between businesses that is designed to restrict

competition.

Classical tax system Tax system in which corporate tax and income tax are levied
separately.

Economics Discipline concerned with man’s search for prosperity;

i.e. acquiring goods and services as cheaply as possible.

Effectiveness of the Manufacturing goods or services that are demanded and

production process appreciated by customers.

Efficiency of the Manufacturing a certain good or service with the least possible
production process costs.

Franchising A sole proprietor affiliates with a chain and is granted access to

certain facilities by paying a fee.

Imputation tax system Tax system in which corporate tax is treated as a prepayment
for income tax.

Job production Products are tailored to the specific wishes of the customer.

Joint-stock company Legal entity in which equity is dividend in shares; can be either
a limited liability company or a public limited company.

Limited partner Partner in a partnership who is not liable for the debts of the
partnership; (s)he is not allowed to participate in the
management.

Mass production A product is manufactured in large quantities, without taking

into account any specific customers’ wishes.

Mission statement Summary of the aims and objectives of an organization.

Organization Alliance between people and resources aimed at achieving

certain aims and objectives.
 38 PART 1 FINANCIAL MANAGEMENT IN BUSINESS © Noordhoff Uitgevers bv

Partnership Non-legal entity in which the partners are owners as well as

managers.

Production Manufacturing goods and services that satisfy human needs.

1
Retail trader Supplies directly to the end user of the goods.

Sole proprietorship Non-legal entity in which one person is owner as well as

manager.

Takeover The purchasing of the majority of the shares of another

company.

Value added tax A tax levied at each stage in the production of a good or service
that results in value being added to the product.

Wholesale trader Purchases from the manufacturer and sells to the retailer.
© Noordhoff Uitgevers bv 39

Multiple-choice
questions 1

1.1 Which of the following organizations is not a business?

a a record store
b a university hospital
c a shipping company
d a tax consultancy firm

1.2 Which of the following activities is not concerned with efficiency?

a purchasing from a selected group of suppliers to achieve bigger discounts
b modifying a product to shorten processing times
c sending sales invoices more quickly
d modifying a product to tailor it to customer wishes

1.3 Which of the following statements is correct?

a Companies tend to find it more difficult to transfer to other activities than
non-profit organizations.
b Non-profit organizations are economically independent, because they rely
on contributions, donations, subsidies, legacies and so forth.
c Extending discounts to reliable customers is a business tactic that can
secure maximum profit.
d The supply of public-sector goods is regulated through the market
mechanism.

1.4 Which of the following statements is incorrect?

a It is more difficult to measure the effectiveness of profit-based businesses
than non-profit institutions.
b Non-profit institutions always strive to operate as efficiently as possible.
c Public-sector goods and services are provided by the government, because
market mechanisms are not suitable for these goods and services.
d A negative financial result for a non-profit organization does not necessarily
imply that the organization has performed poorly.

1.5 Which of the following types of information is not likely to be included in a

mission statement?
a the environmental credentials of the business
b the main product groups offered by the business
c the groups of participants for which the business wants to improve the level
of prosperity
d the expected profit for next year
 40 PART 1 FINANCIAL MANAGEMENT IN BUSINESS © Noordhoff Uitgevers bv

1.6 Which of the following statements is incorrect?

a A service business purchases hardly any raw materials.
b With mass production products are usually manufactured for stock and not
to order.
c The production process of a trading company can be a conversion
1
according to place.
d Service businesses tend to have relatively low labour costs.

1.7 The manufacturing of a car in a saloon and a cabriolet version is called:

a job production
b batch production
c mass production

1.8 Statement : The wholesale trade is ‘business to business’.

Statement : Wholesale trade in seasonal products is important for reducing
the time between production and consumption.
a Both statements are correct.
b Statement  is correct, statement  is incorrect.
c Statement  is incorrect, statement  is correct.
d Both statements are incorrect.

1.9 Which of the following businesses is not obliged to publish financial

statements?
a Johnson Ltd
b Harvey PLC
c Eastman LLC
d Brown & son partnership

1.10 The Torville & Dean partnership has failed to repay a bank loan of €,.
Torville has a % share, Dean a % share in the partnership.
The bank is entitled to demand that Torville pays:
a nothing
b €,
c €,
d €,

1.11 A partnership has two general partners and one limited partner. General
partner A has invested €, in the partnership, general partner B
€, and limited partner C €,. The partnership has a total debt of
€ million. Partner A is liable for:
a €,
b €,
c €,
d € million

1.12 Which of the following statements is incorrect?

a A sole proprietorship is subject to corporate tax.
b Under the imputation system, corporate tax is treated as a prepayment of
income tax levied on the shareholders.
c The ‘company tax burden balance’ aims at striking a balance between
companies that are legal entities and those that are not.
d The partners in a partnership are subject to income tax.
© Noordhoff Uitgevers bv BUSINESSES AND THEIR ROLE IN THE ECONOMY 41

1.13 XYZ Ltd records a profit of €, and distributes half of its profit after
taxation to shareholders. The rate of corporate tax is % and the rate
of income tax is %.
Under the classical system, the total amount in taxes paid is:
a €,
1
b €,
c €,
d €,

1.14 Which of the following statements is incorrect?

a LLCs and PLCs are both joint-stock companies.
b Shareholders are not liable for the repayment of a company’s debts.
c A limited partner in a partnership is liable for the partnership’s debts.
d Only public limited companies can have their shares traded at the stock
exchange.

1.15 A Dutch wholesale trader purchases , radios at a unit price of €
excluding % VAT. The trader sells  radios to Dutch retailers at a selling
price of € excluding % VAT and  radios to a Belgian wholesaler at a
selling price of €.
The Dutch wholesale trader pays the Dutch tax authorities an amount of:
a €
b €,
c €,
d €,

1.16 An industry comprises:

a businesses operating at the same stage of the production process
b businesses operating at all stages of the production process of a single
product
c businesses operating in the same market sector
d competing businesses.

1.17 The owner of a do-it-yourself shop affiliates with a chain, thereby being
allowed to call his shop Hobby Plus.
The owner pays a fee on the basis of his turnover. This is:
a franchising
b a merger
c a takeover
d cartelization

1.18 When businesses enter into a cartel agreement, their aim is:
a to start a new joint-stock company
b to buy out competitors
c to have a stronger bargaining position with regard to the trade unions
d to restrict competition

1.19 Cartelization will predominantly occur in a:

a monopoly
b oligopoly
c competitive market
d all of the above mentioned